Explanation :This metric is a measure of a company’s profitability and strength of operations. In effect, it shows how much cash flow a company generates from its operations. Many investors use this calculation to analyze a company without examining the company’s financing costs, tax burden, and accounting treatments. Since this metric is not a ratio, it’s not used to compare companies of different sizes directly. Also, each company may different greatly from one another when the outside factors are considered. If a company’s EBITDA is negative, it means the business is not profitable even without counting depreciation, amortization, and interest. In other words, it’s in bad shape.
In a nutshell :
- Earnings before interest, taxes, depreciation, and amortization (EBITDA) is a metric that measures a company's overall financial performance.
- In the mid-1980s, investors began to use EBITDA to determine if a distressed company would be able to pay back the interest on a leveraged buyout deal.
- EBITDA is now commonly used to compare the financial health of companies and to evaluate firms with different tax rates and depreciation policies.
- Among its drawbacks, EBITDA is not a substitute for analyzing a company's cash flow and can make a company look like it has more money to make interest payments than it really does.
- EBITDA also ignores the quality of a company's earnings and can make it look cheaper than it really is.